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Anyone responsible for company financing could have been forgiven for simply targeting “survival” through the pandemic and the extraordinary events between 2020 and 2022. However, the magnitude and frequency of disruptions seem to know no bounds. The macroeconomic headwinds faced last year now present another major obstacle for portfolio company CFOs and Private Equity owners to overcome. Survival alone cannot – and should not – become the “new normal”.
A significant maturity wall, to the tune of more than €8.5bn in listed Private Equity debt in Europe, is playing out over the course of this year. On its own, the volume of debt falling due may not be a standout note for concern. However, this debt – taken onto balance sheets pre-COVID during a decade of low interest, low inflation, and light covenants – has transformed from a relatively panic-free part of everyday PE business to emerge as a severe refinancing conundrum to be solved.
In an environment of much-reduced risk appetite and concern over future disruptive forces amongst lenders, how can CFOs prise open the door to refinancing markets as it rapidly closes?
Debt raising in a risk-averse market
Businesses heavily laden with maturing debt are now in a market where refinancing has become significantly more expensive and, in many situations, nearly impossible.
The resilience of certain industries – such as automotive and retail – has been stretched to the limit. The experience of 2022’s spiking input costs and supply chain challenges now serve as warning lights to financing institutions over companies’ ability to survive future crises to come. Even good assets with a degree of disappointment in margins, such as healthcare (related to COVID), are struggling to pay increasing rates on historically high leverage loans. Growing conservatism, rising interest, and a diminishing level of debt available are creating a perfect storm for Private Equity.
For many CFOs relatively new in their role, the debt metamorphosis experienced on their watch is a problem they inherited, yet somewhat perversely it wasn’t a problem at the time of their appointment.
For Private Equity, in hindsight, more robust diligence and stress-testing of some investments on acquisition and/or financing may have minimised the chances of folding companies into their portfolios that are now proving difficult to revitalise, due to deeply hidden issues or simply the passing of the appropriate timing for a call for action. Allied to this, a steady downward trend in interest rates in the past ten years prompted asset financing based on a mid-term vision with a more optimistic view on where the market may be at the point of refinancing, versus the situation they actually face today.
Amid a wave of potential covenant breaches this year, there must be an awakening to the urgent need to improve debt capacity positions and minimise the levels of refinancing required. Even prime assets will likely need to pay double-digit interest rates, as credit funds heavily ration their exposure towards higher quality borrowers. Debt funds could become the gatekeepers of high-risk debt for the coming years, potentially following a more aggressive “loan to own” strategy compared to the very different approach of traditional commercial banks.
Five financing priorities
We see a number of critical actions for finance leaders to prioritise amid the current market dynamics:
- A profound understanding of potential scenarios and risks to prove resilience:
Reflecting on the difficult scenario outlined above that many CFOs must now contend with, the need for more rigorous due diligence is imperative. There has long been a sharp focus on operations, which remains crucial. However, the complexity and criticality of financing has at times been underestimated. Are you happy with the planning scenarios in place? Are you comfortable with your financing structure if further problems were to come your way? If you have a best-case scenario, have you counter-balanced it with a worst-case one to help you act quickly should you need to manage the associated complications? - Creativity in how to grow your debt capacity:
In this climate, the need for true transformation and improvement of the underlying value of a company is vital. Understanding how much debt your asset can take on – in relation to both debt capacity and interest-bearing capability – will lay the pathway towards EBITDA enhancement. Supporting growth, whether it be for purely refinancing purposes or for business improvement initiatives, becomes essential. Are you able to identify any asset collateral suited for backing your loan requirements? These could be assets, shares, or parts of the business – what options do you have that a financing institution will be willing to accept as collateral in exchange for money? - Identification of sources of cash:
Finding a viable and sustainable financing option will need to address all short-, mid-, and longer-term considerations. Bottoming out the fresh money need – to repay debt, close acquisitions, or fund operational requirements – should be underpinned by cash flow analysis of operations under various risk scenarios. To cover short-term needs, have you considered pushing for additional shareholder contributions, extending the maturity of existing loans, or reaching out to additional external lenders? Could there also be options available such as asset-backed lending (real estate, IP etc.) or leveraging internal financing sources in the form of working capital reduction, for example?
- Rationalisation of refinancing options, and contingency plan creation:
Extending or refinancing an entire debt package through a refinancing process will likely be on the table for many companies now. Considering multiple market scenarios twelve months before the end of loan maturity can be crucial to success. Do you have a contingency plan in case your refinancing fails at the end of a loan term? Assessing assets available for carve-out and profitable sale could provide an alternative route to finance, too, improving liquidity prior to approaching the capital market in pursuit of a loan. Contingency plans should extend to understanding how the business will continue to run should anything happen to its operations – do you have a plan that then enables you to continue working in crisis circumstances? Understand the risk for each downturn scenario – for example, a liquidity shortfall – and consider bringing in expertise to maintain control of turnaround measures and assets. - Close management of stakeholders:
Communication remains key during challenging times. Are you actively and regularly speaking to shareholders and other stakeholder groups, including lenders, to update on strategy, successes, and future financing plans?
A climate of such complex financial challenges, high emotions, and time pressure demands that CFOs find a level of transparency and honesty in their analysis of the road ahead. If problems are uncovered, they must be accepted and tackled head-on, as time is of the essence if they are to be effectively mitigated.
Assets can be managed to the best-case scenario, but the worst must be prepared for too. It will always feel better to overachieve the downside of any plan. Not needing the more drastic measures necessary under the worst-case scenario is of course ideal, yet planning for it will provide security to, at the very least, prove that it has shaped overall business thinking. If recent years have taught us anything, it is that even in the business world, Darwin’s “survival of the fittest” theory stands firm, and the fittest will likely be those companies that prove themselves most adaptable to change.
